So, what exactly happens when you kiss today goodbye, figuratively of course, in a construction project with a liquidated damages provision?  Although the past few years of critical labor shortages in subcontractor trades have tested the ability to complete projects within the contract time and contract price, the COVID-19 pandemic presents a challenge on a completely different order of magnitude.

As construction projects shut down due to illness, manpower shortage, or restrictions on travel, there are a few helpful things to know about liquidated damages clauses.

1.     Liquidated Damages ≠ Penalties

Many people in the construction industry, owners, designers and contractors alike, refer to liquidated damages as penalties for not completing the project within the contract time.  From a legal perspective, liquidated damages are not delay penalties.  If they were, liquidated damages provisions would not be enforceable.

Instead, liquidated damages are an estimate of reasonable damages that an owner or developer would incur as a result of delay.  Because those types of damages, which might, for instance, incorporate anticipated lost profits on a new project, are difficult to calculate at the time the contract is signed, the liquidated damage amount, typically expressed as a daily rate, is an estimate.  A penalty, in contrast, is arbitrary, can be unreasonable, is not usually tied to any guideposts, and as the name indicates, is intended to punish errant behavior.  A penalty may also be a liquidated damage amount that overestimates the owner’s actual damages.  More on that a little bit later.

2.    Milestones Matter

Since liquidated damages are a creature of contract, the dates that trigger liquidated damages and the daily rates owed if critical milestones are missed are typically negotiated between the parties before the contract is signed.

Most often, liquidated damages are tied to the contractor reaching substantial completion within the specified contract time. The AIA Document A201, General Conditions for the Contract for Construction, provides the most commonly used definition for substantial completion.  It defines substantial completion as the stage when the constructed improvement is sufficiently complete in accordance with the construction documents to allow the owner to occupy or use the improvements for their intended use. Beneficial use is another term frequently associated with this milestone event.  Sometimes in the absence of an executed formal certificate of substantial completion, the date the improvement receives a certificate of occupancy is used as the date of substantial completion.

Depending the type of construction project, however, the accrual date for liquidated damages or the definition of substantial completion itself may vary significantly. Some projects may have different dates of substantial completion for different phases of the project.  The definition of substantial completion may be altered in the contract negotiation stage to make the definition sound more like final completion—all punch work completed and all governmental approvals and tests obtained.  The accrual date may also be staggered, with different amounts of liquidated damages tied to missing different construction milestones, such as sending submittals.  While these types modifications may seem innocuous, they can result in the owner having the power to offset significant liquidated damages from progress payments or final payments.

To sum it up, milestones and accrual dates matter a lot when it comes to liquidated damages.

3.    Actual Damages Matter, Too

From the contractor’s perspective, the distinction between whether the daily rate for liquidated damages is reasonable or a penalty frequently rests on what amount of damages the owner or developer actually sustains as a result of the delay.  In other words, how does the liquidated damage compare with the actual damage or loss?

Many Texas courts will not enforce a liquidated damages provision if the liquidated damage amount is disproportionate to the owner’s actual damages or of the owner’s damages are caused by its own failure to mitigate damages.  Texas courts typically will characterize a liquidated damage amount as a penalty if it exceeds or is disproportionate to the owner’s actual damages.  In February 2020, the Texas Supreme Court clarified that the party seeking to unwind the liquidated damages provision bears the burden of proving that the liquidated damage amount is unreasonable.

In the COVID-19 era, where many projects were started when the economy was strong, but were completed when the economy was substantially weaker, a close comparison of the liquidated damage amount and the actual damages the owner incurs may prove especially important.

When today is kissed away, whether by COVID-19 or some other event, our attorneys in Dallas and Austin can help point you towards a better tomorrow by answering any questions you may have about your contractual or legal rights.  Contact us at info@gstexlaw.com with any questions you may have.

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